What Happens to Shareholders of a Chapter 11 Bankruptcy?

A Chapter 11 bankruptcy is designed to permit a business the ability to continue functioning, reorganize its operations and restructure its debt. The primary objective of a Chapter 11 bankruptcy is to provide a business the protection it needs to regain a stable and ultimately profitable financial footing.

Oftentimes the type of business that files for Chapter 11 bankruptcy is a corporation. A consideration in such a proceeding is the impact a Chapter 11 bankruptcy has on shareholders.

Legally the shareholders are the owners of a corporation, including one in bankruptcy. Because of the precarious financial situation of a corporation heading into bankruptcy, the value of stock likely dropped. In other words, the shareholders end up with an asset in the form of corporate stock that likely is worth less than when they purchased these securities.

The bankruptcy court in a Chapter 11 case can permit a corporation to alter its stock structure as part of the overall reorganization process. Depending on the nature of the reorganization plan, a plan may be implemented through which existing shares of stock are traded for new shares. A shareholder does not lose her ownership interest through such process but does end up with a different ownership interest in the corporation.

In some instances, as a Chapter 11 bankruptcy proceeds, the bankruptcy court and the management of the corporation conclude that no matter what reasonable steps are taken to reorganize and restructure, the enterprise will not be returned to profitability. In such a case, the assets of the corporation are sold to pay of debts. Creditors have priority over shareholders in such a scenario. As a result, only if assets exist after paying off the corporation’s debt will shareholders receive any type of payment for their stock.

A common misconception associated with a Chapter 11 bankruptcy is that the shareholders have priority over creditors when it comes to rights under the U.S. Bankruptcy Code. In fact, the opposite is true. A shareholder stands in the position of an owner of any other type of business in bankruptcy, a standing not all that different from an individual debtor in a consumer bankruptcy.

Chapter 11 of the U.S. Bankruptcy Code permits the establishment of a shareholders’ committee to represent the interests of those individuals that own stock in a corporation. The committee is vested with the right to participate in hearings and other proceedings during the bankruptcy case.